Traditional Ratio Analysis in The Airline Business - A Case Study of Leading U.S Carriers

ISSN: 2278-3369
International Journal of Advances in Management and Economics

Available online at www.managementjournal.info
Case Study
Traditional Ratio Analysis in the Airline Business: A Case Study of

Leading U.S Carriers
Stepanyan A*
Faculty of Economics and Business Administration West University of Timisoara Str. J. H. Pestalozzi, nr. 16,
300115, Timisoara, Romania.
*Corresponding Author: Email: astepanyan8@gmail.com
Abstract
The paper addresses the traditional ratio analysis in the airline industry based on the U.S example. Given the
specificity of the airline industry and its significant vulnerability to adverse changes in economic and business
conditions, conducting a ratio analysis aims to reveal the airline industry-specific behavior of the selected liquidity,
profitability and solvency ratios computed for eight U.S largest airlines over the period 2007-2012 and find out
whether known rules of thumb are applicable to the airline industry. Moreover, via traditional ratios the paper
examines the financial performance of selected U.S carriers during the given period by identifying major challenges
that they are facing. A brief part in the paper is dedicated to the description of the recent developments in the U.S
airline industry and historically high fuel prices that will allow us to better understand the behavior of ratios over
time.
Keywords: Airline industry, Ratio analysis, Liquidity, Economic recession, Fuel prices, Earnings, Labor costs.
Introduction
The financial ratio analysis has always been depending on their economic characteristics. The
considered as a fundamental element in financial airline industry is highly vulnerable to adverse
statement analysis and involves conducting a economic, financial and business conditions being
quantitative analysis of information disclosed in subject to challenges including historically high
general purpose financial statements of fuel and labor costs that represent largest
companies under review via various accounting operating expenses. Ongoing uncertainties in the
ratios that show relations among different items airline business environment have produced
from the balance sheet, statement of operations profound interest in analyzing traditional
and statement of cash flows and are used to financial ratios’ behavior in this specific industry
evaluate companies’ performance for investing over the last six years based on the case study of
and financing purposes. leading U.S carriers. Over the past decade, U.S
domestic airline operations have been highly
Traditional ratio analysis used to assess the affected by significant events including economic
company’s liquidity, profitability, operating recessions that had hit the U.S economy in 2001
efficiency and solvency has always been subject to and from 2007 to 2009 causing domestic carriers
limitations as it is mainly based on balance sheet to report significant financial losses, terrorist
data which is static and the income statement attacks on September 11, 2001, airline mergers,
which includes various non-cash charges. continuously increasing fuel prices and labor
Therefore, for the purpose of having a more costs, as well as the replacement of older aircrafts
comprehensive picture of a company’s financial with more fuel efficient ones [16].
performance, over the last two decades different
authors including Mills and Yamamura (1998), To manage through consequences of economic
Giacomino and Mielke (1993), Figlewicz and recession and soaring fuel prices, U.S airlines
Zeller (1991) and others have developed various resorted to the capacity reduction that would help
cash flow ratios in an attempt to incorporate a them reduce operating expenses and improve
company’s cash flows into the overall ratio profitability. Despite the recent improvements in
analysis. Financial ratios are industry specific, the airline industry, profitability still remains low
that is, they differ from one industry to another being conditioned by slow growth of air travel
Stepanyan A | March-April 2014 | Vol.3|Issue2|175-189 175

demand, both for cargo and passenger traffic, and different economic characteristics. Therefore, it is
high fuel prices [17]. crucial to identify economic characteristics of an
industry under review and take them into account
Therefore, the paper has a twofold approach in evaluating financial ratios [14]. Erich Helfert
placing emphasis, on the one hand, on the (2001) classifies and discusses financial ratios in
behavior of selected financial ratios inherent in accordance with three major viewpoints:
the U.S airline industry over the past six years management’s viewpoint, owners’ or investors’
and the analysis of selected eight leading U.S viewpoint and lenders’ viewpoint. A certain ratio
carriers’ financial performance, on the other hand. becomes useful when it best serves the objectives
Furthermore, the selected financial ratios for the of the analysis and relates to the viewpoint
leading U.S airlines are examined over a certain defined by the analyst. Managers are more
time period being compared with the historical interested in margin ratios, return on assets,
financial ratios, existing traditional rules of EBIT, EBITDA, turnover ratios, and free cash
thumb, if any to determine whether they are flow whereas investors pay close attention to
applicable to the airline industry, as well as with measures such as return on equity, earnings per
average values of ratios for selected air carriers. share, dividends per share, total shareholder
return, price to earnings ratio, and lenders assess
The paper additionally discusses the current a company’s solvency and liquidity based on the
literature on the ratio analysis, the methodology current ratio, quick ratio, debt ratios and coverage
used to conduct a study, as well as briefly ratios [13].
addresses the overall U.S airline industry
including the recent developments and challenges Unlike Helfert’s classification, James Wahlen et
prevailing in the industry. al. (2008) discuss the use of financial ratios in
relation to the analysis of short-term liquidity
Literature Review
risk, profitability and long-term solvency risk.
The contemporary literature on financial
statement analysis to a significant extent Apart from traditional ratios that are mainly
addresses the use of various financial ratios to based on the balance sheet and income statement,
assess a company’s performance for a certain year George Friedlob and Lydia Schleifer (2003) also
or period of time as the ratio analysis is discuss cash flow ratios which have been
considered as a cornerstone for conducting developed over the past few decades by authors
financial statement analysis [12]. The including Mills and Yamamura (1998) stating
computation of financial ratios based on that cash flow information is much more reliable
information in a company’s financial statements in evaluating a company’s liquidity than
to evaluate profitability, operating efficiency and information in the balance sheet and income
risk is one of the important and useful analytical statement, Giacomino and Mielke (1993) who
tools and shows relations among various balance claim that cash flow ratios are more useful in
sheet and income statement items [24]. assessing a company’s financial strength and
profitability, and Figlewicz and Zeller (1991)
Charles Horngren et al. (2006) state that the most whose cash-flow based analysis showed that it
important part in ratio analysis is the provided supplementary insight into the overall
interpretation and evaluation of financial ratios financial performance of a company.
computed that require making three types of
Methodology
comparisons to determine whether they indicate
good, average or bad performance. These The paper presents a quantitative analysis of
comparisons include time-series analysis which information reported in financial statements of
implies that the set of financial ratios calculated selected U.S leading airlines using traditional
for a certain year are compared with the entity’s financial ratios to not only understand their
historical financial ratios, benchmark analysis behavior specific to the airline industry and
when computed financial ratios are compared trends in the course of time, but also assess the
with general rules of thumb and cross-sectional U.S major airlines’ financial performance for six
comparisons that imply an analysis of a successive years (2007-2012) which will reveal the
company’s financial ratios in relation to those of main challenges that airlines are currently facing.
peers or industry averages. Nevertheless, Larson As a source of information, airlines’ 10-k form
and Miller (1995) claim that the financial ratios of annual reports filed with the Securities and
competing companies under review are considered Exchange Commission (SEC) are used to calculate
as standards that best serve comparison whereas set of financial ratios. The paper primarily places
rules of thumb are not so reliable as they cannot emphasis on the assessment of airlines’ financial
be similarly applied to all industries with performance and conditions via traditional ratios

employed to measure profitability and risk and airline competition, the demand for air traffic and
does not encompass a cash-based analysis. The operating expenses. Prior to the deregulation of
following set of financial ratios and measures U.S airline industry, the CAB bore the
presented in the table 1 are the concern of our responsibility of setting airfares and determining
analysis and are classified in accordance with the routes for each airline to operate flights. A few
areas of financial statement analysis, that is, events that occurred throughout 70s led to the
short-term liquidity analysis, profitability signing of Airline Deregulation Act into law,
analysis, long-term solvency analysis. including the introduction of wide-body aircraft
that increased airline capacity on many
Table 1: Traditional financial ratios in international routes. The capacity increase
compliance with three major areas of analysis resulted in more operating expenses, and unable
Short -term Profitability Long-term solvency
liquidity analysis analysis
to set prices, U.S carriers could not manage to
analysis cover additional costs. Moreover, the oil embargo
Working Net income (loss) Long-term Debt to by OPEC in 1973 brought about an increase in
capital including special Equity ratio
items
fuel prices.
Current ratio Return on Assets Debt to Capitalization
(ROA) ratio The financial condition of airlines worsened when
Quick ratio Total assets turnover Total Debt to Total
Equity ratio
the demand for air traffic dropped at the time of
Cash ratio Fixed assets turnover Total Debt to Total increased capacity and rising fuel costs.
Assets ratio As a result, to improve profitability the CAB
Accounts Operating profit Interest coverage (Times permitted airlines to increase air fares and reduce
receivable margin interest earned ratio)
turnover capacity. Nevertheless, the CAB failed to
Days' sales EBIT margin Earnings to Fixed significantly improve airlines’ financial condition,
uncollectable Charges ratio and the airline profitability continued to remain
Operating cash EBITDA margin Operating cash flows to low throughout 1970s [3].
flow to current Total debt
liabilities
Profit margin The airline deregulation resulted in highly
increased competition, decreased air fares and
Return on Equity
(ROE) growth in demand for air transportation. Today,
over 100 certified airlines operate in the U.S
Subsequently, the tables presented in the paper airline industry as opposed to 43 certified carriers
provide a summary of the liquidity, profitability in 1978 [3]. Not only do major U.S airlines
and solvency ratios calculated for each of the U.S compete with each other, but also with regional
major airlines including Delta Air Lines, United air carriers that operate flights in the small and
Continental Holdings, Continental Airlines, AMR medium-sized markets. An intense rivalry among
Corporation, United Airways Group, Alaska Air carriers also exists in international markets [7].
Group, Southwest Airlines and JetBlue Airways
allowing us to compare them with their historical A few significant events that have occurred over
values over the course of six consecutive years the past decade adversely affected U.S airlines’
(2007-2012) by identifying trends and major operations and financial condition. The most
changes, as well as with existing rules of thumb to noteworthy events include 1) economic recessions
find out whether they are applicable to the airline from March to November 2001 and from
industry. Subsequent to a time-series and December 2007 to June 2009, 2) terrorist attacks
benchmark analysis, a comparative analysis that occurred on September 11, 2001 and resulted
among selected U.S largest airlines is made that in decreased demand for air travel, 3) airline
involves comparing ratios of each airline with mergers, 4) soaring fuel prices and labor costs,
those of peers and average values. and 5) replacement of old aircrafts with new fuel
effective ones [16].
Recent Developments in the US Airline
Industry: Historically High Fuel Prices The economic recessions, volatile and incremental
and Labor Costs fuel prices and terrorist attacks early in 2000s
caused the airline earnings to significantly drop,
A turning point for the U.S airline industry was
in some years even turn negative. Profitability
the passing of Airline Deregulation Act by
thus has been poor throughout the past decade
Congress on October 24, 1978 as a result of which
and continues to remain so even today in the face
the Civil Aeronautics Board (CAB), a government
of all the recent improvements in the airline
agency, loosened its control over the airline
industry. Most importantly, to reduce operating
industry allowing airlines to easily gain access to
expenses, improve profit margins and better cope
new routes and freely determine prices driven by
with consequences of the recession-related

decreased demand for air travel, soaring jet fuel airlines have begun to replace old aircrafts with
prices and other external factors, U.S airlines newer and more fuel efficient ones [16].
reduced capacity on many international and The following figure shows the volatility in
domestic routes to match demand [1]. earnings in the airline industry over the past
Furthermore, to increase fuel productivity U.S decade.
Fig. 1: Operating profit and net income for calendar years 2000-2012 [18]
As we can see from the Fig. 1, the U.S airline airlines paid in December 2000 after adjusting for
industry has experienced significant losses during inflation as illustrated in the Fig. 2. To reduce
2001 and 2007-2009 economic recessions, in 2002 consequences of soaring fuel prices, many airlines
as a result of the terrorist attack-related enter into fuel hedge agreements to secure from
decreased demand for air transportation and in possible increases in fuel prices [16].
2005 in the aftermath of soaring jet fuel and labor
costs and the hurricane Katrina that caused Economic recessions, soaring fuel and labor costs
extensive damage to southern states [2]. in the past decade resulted in several airlines
Nonetheless, in the ensuing years both airlines’ filing for bankruptcy protection under Chapter 11,
operating profit and net earnings began to slowly including filings of U.S Airways in 2002 and 2004,
increase with the improvements in the global United Airlines in 2002, Northwest Airlines and
economic environment. Delta Air Lines in 2005 and lastly the filing of
American Airlines in late 2011 for the first time in
Historically high fuel prices have significantly the airline’s history [21]. Furthermore, airline
impacted airlines’ operations and financial mergers in the U.S airline industry have recently
condition throughout the past decade and become more frequent as a means of better
continue to remain a significant challenge for U.S copying with financial and economic challenges
airlines as the fuel has become the largest [4].
operating expense since 2000 when fuel prices
began to continuously rise. Today, both the fuel Similar to fuel expense, U.S airlines have
and labor costs constitute more than 25 percent of experienced a continuous increase in labor costs
airline operating expenses [16]. The highest price which has become the second largest operating
for fuel that U.S air carriers paid was in July expense over the past decade due to the labor-
2008 and amounted to 3.83$ per gallon of fuel intensive airline industry and the expansion of
(147$ per barrel). The graphical illustration airline operations worldwide. The Fig. 3
presented below (Fig. 2) shows unadjusted and illustrates the increasing trend in salaries and
inflation adjusted fuel cost per gallon. related costs for eight U.S largest airlines for the
last six years. The main factor that has driven
In December 2012 U.S airlines with annual salaries, wages and related costs upward is the
revenue of $20 million or more paid on average substantial role that labor unions play in the U.S
3.13 $ per gallon of fuel for domestic scheduled airline industry. According to IATA (International
and nonscheduled services, 10.6 percent more Air Transport Association), almost half of the
than they paid in December 2011, 11.3 percent airline employees are members of labor unions,
more as compared to December 2010 and around while the other half of workers has concluded
33 percent more than the average fuel price collective bargaining agreements with unions.
Fig 2:Fuel cost per gallon 2000-2012 unadjusted and adjusted for inflation [19]
(To adjust for inflation Consumer Price Index (CPI) for fuel oil and other fuels was used, base year 2012= 335.908 [22])
Fig. 3: Salaries and related costs for eight U.S biggest airlines for years 2007-2012 [27]
All US largest airlines presented in the Fig.3 are The Federal Aviation Administration’s long-term
greatly unionized, and therefore, there is a outlook for the U.S airline industry is quite
significant pressure placed by labor unions on optimistic. The FAA estimated that the airline
management of airlines in regard to salary levels. industry will sustainably grow in the long-term,
The existing strong bargaining power of labor but will remain moderate in the short-run, in
unions is attributable to the possible strike particular for the next five years, primarily due to
threatened by airlines’ pilots, flights attendants, the slow growth in the U.S and European
mechanics and other employees that can highly economies [8].
affect daily flight operations [25]. As Fig. 3 shows,
Evaluation of Leading U.S Airlines’
among major US carriers AMR Corporation has
reported incredibly high salaries and related costs Financial Performance via Traditional
over the period of 2007-2012 that has long been Ratios: Research Findings and
struggling to reduce wages and salaries through Discussion
negotiations with labor unions and eventually, The assessment of selected airlines’ financial
filed for bankruptcy protection under Chapter 11 performance involves analyzing the short-term
to reduce costs blaming the filing on high labor liquidity, profitability and long-term solvency in
costs and fuel prices [26]. the respective order as described below.

Liquidity Analysis of U.S Leading Carriers can conclude that U.S airlines, especially Alaska
Air Group and Continental Airlines, have mostly
For the examination of liquidity ratios in the
invested in highly liquid assets including cash,
airline business, six U.S legacy carriers including
short-term investments and accounts receivables
Delta Air Lines, United Continental Holdings
that can readily be converted to cash.
(United Airlines and Continental Airlines since
Furthermore, if we eliminate accounts receivable,
2010), Continental Airlines (the company
we arrive at a stricter ratio, cash ratio, which
operated as a stand-alone airline until 2012
considers cash, cash equivalents and short-term
despite the merger agreement with United), AMR
investments. The closer to 1 the cash ratio is, the
Corporation (a parent company of American
better the company is positioned in terms of
Airlines), Alaska Air Group and U.S Airways
meeting its short-term obligations. For the
which had been founded long before the airline
selected U.S airlines the cash ratio on average has
deregulation, and two low-cost airlines including
been in the range of 0.49 - 0.72 and dropped to
Southwest Airlines and JetBlue Airways have
0.57 in 2012.
been selected and analyzed. The results of
calculations of selected liquidity ratios for eight
Separately considered, Continental Airlines,
U.S major airlines are illustrated in the table 2
Alaska Air Group and Southwest on average have
which also includes average values of ratios for
had high cash ratio whereas Delta Air Lines and
each given year.
AMR Corporation have had the lowest.
Eventually, AMR Corporation filed for
For the most part, selected U.S carriers have been
bankruptcy protection under Chapter 11 in late
operating with negative or low working capital
2011 not being able to meet its short-term
during the given time span, in particular United
commitments. The interpretation of accounts
Continental Airlines, Delta Air Lines and AMR
receivable turnover and days’ sales uncollected is
Corporation, three biggest airlines in the world as
quite hard in that the credit terms are not
of 2012 that have had only negative working
available. However, taking into account the fact
capital over the six-year period which implies
that in practice many companies provide credit
higher riskiness in terms of liquidity matters. The
sales on payment terms of 30 days, leading U.S
negative or positive but low working capital can
carriers collect their accounts receivable in less
primarily be explained by major U.S airlines
than 30 days.
being highly leveraged which requires periodic
payments of the current portion of long-term debt,
Lastly, the average values of the ratio of cash
increasing accrued liabilities, in particular
flows to current liabilities indicate that selected
salaries and related benefits, significant amounts
carriers do not generate high cash flows from
of air traffic liability (unearned revenue), low cash
operating activities to cover a greater part of
flows from operations and continuous significant
current liabilities.
capital investments, especially in aircrafts. Of
selected U.S airlines under review, Alaska Air
In conclusion, the results may indicate that eight
Group has only had a positive working capital
U.S largest carriers are very much likely to face
during the period 2007-2012, but it is a relatively
liquidity issues in the short run as they are highly
smaller airline in terms of flight operations,
vulnerable to adverse business, financial and
operating revenue and revenue passenger miles
economic conditions.
as compared, for example, to United, Delta or
American Airlines. The analysis of liquidity ratios Profitability Analysis of U.S Leading
for selected airlines shows that the values of the Carriers
current ratio have been less than 1 or slightly
Historically high fuel prices, the 2007-2009
above it which indicates that the traditional rule
economic recessions, slowing U.S economy and the
of thumb 2 to 1 for the current ratio is not
slow growth in demand for air transportation in
applicable in the U.S airline industry whereas the
recent years have adversely impacted profitability
rule of thumb of 1 to 1 for the quick ratio has been
in the U.S airline industry. Even today, soaring
reached only by Southwest Airlines in 2009 and
jet fuel prices and labor costs highly prevent
2010, U.S Airways in 2007, JetBlue Airways and
airlines from generating significant profit. The
Alaska Air Group in 2009. For the rest of the
results of profitability analysis for selected largest
airlines and years the values of the quick ratio
U.S airlines are summarized in the table 3 that
have been less than 1.
includes eight profitability ratios calculated for
six consecutive years.
By examining average values for the current ratio
and the quick ratio calculated for selected
The values of selected profitability ratios,
carriers, as well as differences between them, we
especially the profit margin and operating profit

margin, indicate low profitability in the airline Of all profitability ratios, the values of return on
industry due mainly to slow growth in demand for equity of U.S airlines, in particular legacy carriers
air traffic, increasing operating expenses driven including Delta Air Lines, United Continental
by rising jet fuel expenses and labor costs and the Holdings, AMR Corporation and U.S Airways
overall economic condition worldwide. Group, will undoubtedly draw our attention in
that for some of the years ROE was not measured
The impact of the recent economic downturn is due to the fact that total stockholders’ equity was
obviously reflected in ratio values for 2008 and negative conditioned by the accumulated deficit
2009 when most of the largest U.S airlines and other comprehensive loss mainly resulted
reported significant financial losses as illustrated from financial losses airlines incurred during the
in the table 3. The improvements in the global years of the economic recession. As a consequence,
economic environment in late 2009 resulted in the this has resulted in airlines reporting either
slowly increasing demand for air transportation, negative or very low total stockholders’ equity
in particular business travels, which allowed U.S which, in its turn, accounts for high return on
leading airlines to report profit for the following equity, for example, for United Continental
years except for AMR Corporation, the parent Holdings in 2011, Delta Air Lines in 2010 and U.S
company of American Airlines, which continued to Airways in 2011 and 2012 that on the first face
increasingly incur losses might indicate high profitability. Among legacy
carriers Continental Airlines and Alaska Air
As a result, in late 2011 AMR Corporation was Group have had relatively higher values of ROE
forced to voluntarily file for bankruptcy protection over the six-year period. Therefore, the better
under Chapter 11 of U.S bankruptcy code not financial conditions and relatively higher
being able to meet its short and long-term profitability of Continental Airlines were one of
commitments. The Chapter 11 of U.S bankruptcy the main reasons that UAL Corporation, a parent
code allowed the airline to continue its air traffic company of United Airlines, made a decision to
operations and at the same time go through the merge with Continental in 2010 which would
restructuring process according to the allow United to become financially stronger and
reorganization plan proposed by interested even avoid possible bankruptcy [6] whereas
parties [5]. Alaska Air Group is relatively much smaller
compared to other legacy carriers and serves
The results show that for the most part major U.S smaller markets thus being less vulnerable to
airlines have improved the values of profitability global economic, business and financial conditions
ratios since 2010 as compared to 2009.
Table 2: Liquidity ratio analysis of U.S leading airlines for years ended December 31, 2007-2012
(in millions $ except ratio data) 2007 2008 2009 2010 2011 2012 Average for 6 years
United Working capital (in million $) (1,884) (2,415) (1,368) (600) (397) (2,769) (1,572)
Continental Current ratio times 0.76 0.67 0.79 0.95 0.97 0.78 0.82
Holdings, Inc
Quick ratio times 0.56 0.38 0.58 0.81 0.80 0.61 0.62
Cash ratio times 0.45 0.28 0.47 0.69 0.68 0.51 0.51
AR turnover times 23.59 25.21 22.42 19.80 24.98 27.56 23.93
Days' sales uncollected Average days 15.47 14.48 16.28 18.43 14.61 13.24 15.42
Operating cash flows times 0.27 (0.16) 0.14 0.20 0.20 0.08 0.12
to current liabilities
Continental Working capital (in million $) 112 (127) (16) 397 663 (568) 77
Airlines, Inc Current ratio times 1.03 0.97 1.00 1.08 1.14 0.88 1.02
Cash ratio times 0.63 0.59 0.65 0.82 0.86 0.71 0.71
Delta Air Lines, Working capital (in million $) (1,365) (2,118) (1,806) (4,078) (4,972) (4,998) (3,223)
Inc Current ratio times 0.79 0.81 0.82 0.64 0.61 0.62 0.72
Cash ratio times 0.42 0.40 0.48 0.32 0.28 0.25 0.36

AMR Corporation Working capital (in million $) (1,254) (3,435) (1,086) (1,942) (1,873) (2,232) (1,970)
(American Current ratio times 0.85 0.63 0.86 0.78 0.78 0.76 0.78
Airlines)
Cash ratio times 0.53 0.33 0.57 0.51 0.46 0.42 0.47
Southwest Working capital (in million $) (395) (153) 663 974 (188) (423) 80
Airlines, Co. Current ratio times 0.92 0.95 1.25 1.29 0.96 0.91 1.05
Cash ratio times 0.57 0.64 0.96 1.07 0.69 0.64 0.76
(in millions $ except ratio data) 2007 2008 2009 2010 2011 2012 Average for 6 years
U.S Airways Working capital (in million $) 796 (626) (458) 69 (111) 279 (9)
Group, Inc Current ratio times 1.31 0.79 0.84 1.02 0.96 1.08 1.00
Cash ratio times 0.85 0.35 0.47 0.65 0.62 0.72 0.61
JetBlue Airways, Working capital (in million $) (140) (119) 377 267 216 (508) 15.5
Corp. Current ratio times 0.89 0.89 1.33 1.24 1.15 0.68 1.03
Cash ratio times 0.66 0.52 0.98 0.88 0.87 0.45 0.73
Alaska Air Group, Working capital (in million $) 17 148 365 237 86 236 181.5
Inc Current ratio times 1.01 1.11 1.29 1.17 1.06 1.16 1.13
Cash ratio times 0.60 0.79 0.94 0.85 0.76 0.83 0.79
Operating cash flows times 0.37 0.13 0.22 0.41 0.47 0.50 0.35
Average values for Current ratio times 0.95 0.85 1.02 1.02 0.95 0.86
eight U.S leading Quick ratio times 0.70 0.58 0.79 0.82 0.75 0.65
airlines for each
given year Cash ratio times 0.59 0.49 0.69 0.72 0.65 0.57
Operating cash flows times 0.33 (0.15) 0.19 0.33 0.27 0.27
Unlike legacy carriers, low-cost carriers including profit as is the case with Southwest Airlines, the
Southwest Airlines and JetBlue Airways have largest low-cost airline in the world. The
much more adequate return on equity as shown in incurring of small loss or the reporting of profit by
the table 3 due mainly to the fact that during the two above mentioned low-cost carriers during the
2007-2009 economic recession they had incurred recent economic downturn is attributable to the
small losses as is the case with JetBlue Airways following factors: first of all, they have lower
in 2008 or even ended the years of recession with operating cost structure as compared to
competitors and operate point-to-point operating average values of several selected ratios for eight
model as opposed to mainline carriers with a hub- largest U.S airlines.
and-spoke operating model. Second, in the face of
Long-term Solvency Risk Analysis of U.S
rising fuel costs, low-cost carriers have
Leading Carriers
experienced a moderate drop in operating profits
as opposed to legacy carriers due to the fact that The table 4 illustrates the results of debt and
low-cost carriers have purchased a large portion coverage ratios computed for eight U.S largest
of fuel under hedge contracts whereas legacy airlines which indicate that selected airlines are
carriers have concluded hedge agreements to a highly leveraged, that is, they have significantly
lesser degree [16]. more debt than stockholders’ equity or interest-
bearing debt and other liabilities account for a
As for the return on assets (ROA) that measures major part of airlines’ assets thus putting them at
the operating efficiency of employing assets to higher long-term solvency risk. The average
generate profit, we can notice that selected U.S values of long-term debt-to-equity and long-term
airlines highly improved the ROA measure in debt-to-capitalization ratios calculated for
2010 as compared to 2009 and 2008 as the U.S selected eight air carriers indicate that on average
economy began to recover from the 2008-2009 airline long-term debt including capital lease
recession resulting in growing demand for air obligations is considerably more than twice the
transportation. As a result, U.S airlines have equity whereas interest-bearing debt obligations
increased their capacity to meet the slowly for the most part constitute more than 80% of
increasing air traffic demand that allowed them airlines’ capitalization and even exceeded it both
to generate higher passenger revenue. Among U.S in 2011 and 2012 due to negative total
legacy carriers United Continental Holdings stockholders’ equity which is very uncommon in
experienced a considerable drop in ROA in 2012 practice. It is important to note that high debt
resulted from financial losses incurred due ratios are primarily attributable to low amounts
primarily to slowing demand for air traffic in 2012 of stockholders equity reported by most of the
and highly increased operating expense in the selected carriers, in particular legacy carriers.
first place driven by soaring fuel prices and labor The stockholders’ equity reported even turned
costs [23]. Furthermore, AMR Corporation has negative for airlines including Delta in 2011 and
had the worst results of ROA for six successive 2012, AMR Corporation since 2008, U.S Airways
years, in particular in 2012, due to continuous net and United Continental Holdings in 2008 and
losses incurred since 2008 whereas the rest of the 2009.
legacy carriers and low-cost carriers saw increase
in ROA for 2012 with U.S Airways and Alaska Air The low or negative amounts of airline
Group having the highest operating efficiency of stockholders’ equity have essentially resulted
using assets to generate profit. from accumulated financial losses incurred during
years of the economic recession. The
Analyzing the profit margin for eight U.S largest contemporary literature on financial statement
airlines with Alaska Air Group having the highest analysis points out that the optimal value of the
values of profit margin and AMR Corporation debt-to-equity ratio is deemed to approximate 1
having the worst brings us to the conclusion that which implies that liabilities equal equity and the
airline profitability has been significantly low maximum acceptable debt-to-equity ratio is
over the six-year period despite all the recent considered to be 1.5-2 or less while the rule of
improvements in the industry. Therefore, one of thumb for debt-to-assets expressed in percentages
the main challenges for airlines is the efficient is considered to be from mid-30s to the low of 40s.
management of their operating expenses and the
ability to keep them at a competitive level that However, given the fact that these debt ratios are
would enable them to improve profitability. In industry specific, the above mentioned optimal
addition, the table contains margins based on and acceptable values are not similarly applicable
non-GAAP measures such as earnings before to the airline business as shown in the table 4. We
interest and taxes (EBIT) and earnings before can see that for selected eight carriers the ratios
interest, taxes, depreciation and amortization of debt-to-equity and debt-to-assets on average
(EBITDA) that eliminate the effects of different have ranged from 5 to 21 and from 79% until 95 %
capital structures and tax rates, as well as special respectively due to the airline industry being both
items (non-recurring) and non-cash charges such capital-intensive and labor-intensive.
as depreciation and amortization expense thus
allowing a better understanding of airlines’ As far as coverage ratios are concerned, the
profitability. Lastly, the table displays the values of the interest coverage and the ratio of

earnings to fixed charges that incorporates also U.S carriers to recover from the consequences of
the portion of rental expense representative of the 2008-2009 recession. Meantime, the
interest factor in addition to interest expense traditional ratio analysis of selected carriers has
including capitalized amounts show that on shown that the existing rules of thumb for
average selected airlines have been able to cover computed ratios including current ratio (2:1),
interest expense and rental expense with quick ratio (1:1) and some of the debt ratios are
earnings before interest and taxes for the last not applicable to the airline business due to its
three years presented, but could not do so during specificity. Not only do these computed ratios
the period of the 2008-2009 economic downturn reflect the implications of the recent economic
except Southwest Airlines that managed to downturn and following slow improvements in the
generate sufficient earnings to cover both interest industry, but also reveal the airlines’ financial
expense and fixed charges . problems that they have experienced over the
past six years or might even experience in the
In comparing U.S airlines in terms of long-term near-term.
solvency risk, the results reveal that Alaska Air
Group, Inc is relatively less financially leveraged The analysis of airlines’ short-term liquidity risk
as opposed to other legacy carriers that are bigger has showed that during the given period of time
in terms of assets, passenger revenue, revenue- they have been operating with negative or very
passenger miles and have a significantly larger low level of working capital, current ratio less or a
route network whereas AMR Corporation has bit higher than 1, quick ratio mainly less than 1
been the most vulnerable to risk. Furthermore, which may indicate that airlines under review are
Southwest Airlines, the biggest low-cost airline in quite likely to face liquidity risk in the short run.
the world, pronouncedly catches our eye with the Furthermore, via profitability ratios we have seen
values of its debt and coverage ratios that allow that profitability in the airline industry has been
the company to stand out among selected U.S poor throughout the six-year period and remains
carrier as a financially stronger airline and less so in the face of improvements primarily due to
vulnerable to adverse economic and business losses incurred during the economic recession,
conditions. As the table 4 illustrates, for slowing demand for air travel and increasing
Southwest long-term debt constitutes on average operating expenses mainly driven by rising fuel
approximately 50% of its equity, total liabilities expenses and labor costs whereas the analysis of
on average account for 60% of the total assets long-term solvency risk has indicated high
whereas the portion of interest-bearing debt in financial leverage in the U.S airline industry
the capitalization on average approximates 35% which puts the leading carriers at higher risk
over the six-year period. For the reason of being although coverage ratios have showed that on
less subject to long-term solvency risk, Southwest average selected air carriers have been able to
has been given an investment grade (BBB-) by cover interest expense and other fixed charges
credit rating agency Standard & Poor’s as opposed since 2010 when the global economic environment
to the rest of the selected airlines that have began to gradually better.
received a speculative grade that classifies them
as more vulnerable to adverse economic, business One of the limitations of this paper is that the
and financial conditions [20]. traditional ratio analysis is based on balance
sheets that contain static information and
Conclusion
statements of operations that include special
Having examined the airline industry based on items being non-recurring by their nature that, as
the U.S example and underlying challenges that a matter of fact, distort net earnings. Therefore,
airlines are facing we saw that U.S airline the further analysis will require adjusting
business has been to a significant extent battered earnings to exclude special items for better
by recent economic crisis that has resulted in comparison among airlines, as well as including
decreased demand for air travel, as well as by set of cash flow ratios into the analysis for having
high historical jet fuel prices which still remain a a more comprehensive picture.
major obstacle for airlines to generate higher
profit. Nevertheless, since 2010 the global
economy has begun to slowly improve enabling
Table 3: Profitability ratio analysis of U.S leading airlines for years ended December 31, 2007-2012
(in millions $ except ratio data) 2007 2008 2009 2010 2011 2012 Averag
e for 6
years
United Net income(loss) including special (in 360 (5,396) (651) 253 840 (723) (886)
Continental items millions)

Holdings, Inc Operating profit margin % 5.15 (21.98) (0.99) 4.18 4.91 0.10 (1.44)
EBIT margin % 4.61 (5.26) (2.07) 7.19 6.22 3.67 2.39
EBITDA margin % 9.20 (0.58) 3.54 11.82 10.39 7.76 7.02
Profit margin % 1.79 (26.72) (3.99) 1.08 2.26 (1.95) (4.59)
Return on assets (ROA) % 3.25 (23.06) (1.48) 2.61 3.70 (0.54) (2.59)
Assets turnover times 0.81 0.92 0.86 0.80 0.96 0.98 0.89
Fixed assets turnover times 1.77 1.86 1.62 1.74 2.22 2.20 1.90
Return on Equity (ROE) % 15.77 (11125.7 N/A N/A 47.55 (63.23) -
7)
Note: EBIT and EBITDA from ongoing operations and exclude special items and other non-recurring items whereas the rest of the profitability
ratios include special items. The calculation of ROE for 2009 and 2010 is not applicable (N/A) due to negative average stockholders' equity.
Continental Net income(loss) including special (in 439 (586) (282) 346 569 527 169
Airlines, Inc items millions)
Operating profit margin % 4.83 -2.03 (1.14) 4.86 5.87 4.44 2.81
EBIT margin % 4.92 (0.85) 0.01 6.59 6.86 6.44 3.99
EBITDA margin % 7.82 2.00 3.92 10.47 9.72 9.93 7.31
Profit margin % 3.08 (3.82) (2.23) 2.41 3.52 3.10 1.01
Return on assets (ROA) % 5.78 (2.93) (0.51) 3.47 3.85 3.60 2.21
Return on Equity (ROE) % 46.28 (70.05) (79.10) 14.12 13.18 12.15 (10.57)
Note: The ratios do not exclude special items and other non-recurring items except for EBIT and EBITDA margins.
Delta Air Net income(loss) including special (in 1,612 (8,922) (1,237) 593 854 1,009 (1,015)
Lines, Inc items millions)
Operating profit margin % 5.72 (36.63) (1.15) 6.98 5.62 5.93 (2.25)
EBIT margin % 5.72 0.50 0.30 8.40 6.31 7.16 4.73
EBITDA margin % 11.80 6.08 5.77 13.16 10.65 11.43 9.81
Profit margin % 8.42 (39.31) (4.41) 1.87 2.43 2.75 (4.71)
Return on assets (ROA) % 7.82 (21.84) (0.91) 3.19 3.60 3.78 (0.73)
Return on Equity (ROE) % 3.22* (162.41) (221.09) 103.85 N/A N/A -
Note: the value of ROE for 2007 (3.22%) is computed for eight months ended December 31 (May 1- December 31, 2007) as a result of fresh- start
reporting related to Delta's emergence from bankruptcy protection under Chapter 11 on April 30, 2007. The calculation of ROE for years 2011
and 2012 is not applicable in that the average total stockholders' equity is negative. EBIT and EBITDA from ongoing operations are adjusted to
exclude special items. Except for EBIT and EBITDA, all of the other measures include special items and other non-recurring items.
e for 6
years
AMR Net income (loss) including special (in 456.0 (2,118.0 (1,468.0 (471.0 (1,979.0 (1,876.0 (1,242.6
Corporation items millions) 0 0) 0) 0) 0) 0) 7)
(American
Airlines) Operating profit margin % 4.21 (7.95) (5.04) 1.39 (4.40) 0.43 (1.89)
EBIT margin % 4.48 (2.84) (4.18) 1.39 (1.37) 1.99 (0.09)
EBITDA margin % 9.72 2.23 1.36 6.32 3.16 6.07 4.81
Profit margin % 1.99 (8.91) (7.37) (2.12) (8.25) (7.55) (5.37)
Return on assets (ROA) % 3.70 (6.02) (4.00) 0.17 (6.00) (6.24) (3.07)
Return on Equity (ROE) % 44.47 N/A N/A N/A N/A N/A -
%
Note: EBIT and EBITDA are from ongoing operations and exclude special charges while the rest include special items. ROE is not applicable for
2008-2012 due to negative average total stockholders' equity and financial losses.
Southwest Net income including special items (in 645 178 99 459 178 421 330
Airlines, Co millions)
Operating profit margin % 8.02 4.07 2.53 8.16 4.43 3.65 5.14
EBIT margin % 8.02 4.07 2.53 8.23 5.28 4.72 5.48
EBITDA margin % 13.65 9.51 8.48 13.42 9.85 9.66 10.76
Profit margin % 6.54 1.61 0.96 3.79 1.14 2.46 2.75
Return on assets (ROA) % 4.56 1.60 1.46 3.74 1.77 2.74 2.64
Return on Equity (ROE) % 9.63 2.99 1.90 7.85 2.71 6.07 5.19

Note: EBIT and EBITDA are from ongoing operations and exclude special charges and other non-recurring items whereas the rest include special
items.
U.S Airways Net income including special items (in 423 (2,215) (205) 502 71 637 (131)
Group, Inc millions)
Operating profit margin % 4.56 (14.85) 1.13 6.56 3.26 6.19 1.14
EBIT margin % 5.40 (9.09) 1.65 6.60 3.45 6.43 2.41
EBITDA margin % 7.02 (7.32) 3.97 8.68 5.26 8.21 4.30
Profit margin % 3.62 (18.28) (1.96) 4.22 0.54 4.61 (1.21)
Return on assets (ROA) % 7.72 (26.84) (0.10) 9.37 3.51 9.70 0.56
Return on Equity (ROE) % 35.12 (468.78) N/A N/A 60.68 135.53 -
Note: EBIT and EBITDA are from ongoing operations and exclude special items. ROE for 2008 and 2009 is not applicable due to negative average
stockholders' equity.
e for 6
years
JetBlue Net income including special items (in 12 (84) 61 97 86 128 50
Airways Corp. millions)
Operating profit margin % 5.95 3.33 8.66 8.81 7.15 7.55 6.91
EBIT margin % 5.70 2.65 8.63 9.31 7.15 7.19 6.77
EBITDA margin % 11.89 8.70 15.55 15.14 12.32 12.36 12.66
Profit margin % 0.42 (2.48) 1.85 2.57 1.91 2.57 1.14
Return on assets (ROA) % 2.62 0.76 2.95 3.22 2.91 3.35 2.64
Return on Equity (ROE) % 1.21 (7.30) 4.34 6.06 5.04 7.02 2.73
Note: EBIT and EBITDA from ongoing operations are adjusted to exclude special items.
Alaska Air Net income including special items (in 124 (136) 122 251 245 316 154
Group, Inc millions)
Operating profit margin % 6.02 (4.70) 7.87 12.29 10.40 11.42 7.22
EBIT margin % 6.42 (3.56) 9.18 12.63 11.30 11.42 7.90
EBITDA margin % 11.48 2.03 15.62 18.63 17.02 17.09 13.65
Profit margin % 3.55 (3.71) 3.58 6.55 5.67 6.79 3.74
Return on assets (ROA) % 3.81 (1.78) 3.75 6.34 5.77 6.48 4.06
Return on Equity (ROE) % 13.01 (16.11) 15.85 25.39 21.50 24.35 14.00
Note: EBIT and EBITDA from ongoing operations are adjusted to exclude special items
Average values Operating profit margin % 5.56 (10.09) 1.48 6.66 4.66 4.96
for selected EBIT margin % 5.66 (1.80) 2.01 7.54 5.65 6.13
profitability
ratios of eight Profit margin % 3.67 (12.70) (1.70) 2.55 1.15 1.60
leading U.S Return on assets (ROA) % 4.91 (10.01) 0.14 4.01 2.39 2.86
airlines for each
given year
*N/A- Not Applicable
Table 4: The analysis of long-term solvency risk of major U.S airlines for years ended December 31, 2007-2012
(In U.S dollars) 2007 2008 2009 2010 2011 2012 Ave.
for 6
years
United Continental *Long-term Debt to Equity ratio times 3.11 (3.04) (2.69) 7.22 6.33 23.35 5.71
Holdings, Inc
*Debt to Capitalization ratio times 0.78 1.41 1.49 0.90 0.88 0.96 1.07
*Total Debt to Total Equity ratio times 8.86 (9.39) (7.65) 21.93 20.03 77.23 18.50
*Total Debt to Total Assets ratio % 88.48 111.92 115.04 95.64 95.25 98.72 100.84
*Interest coverage times 1.35 (1.93) (0.60) 2.14 2.52 1.71 0.87
Earnings to Fixed Charges ratio times 1.55 (4.19) 0.36 1.18 1.44 0.57 0.15
*Operating cash flow to total debt times 0.25 (0.15) 0.11 0.13 0.19 0.07 0.10
Continental Airlines, Long-term Debt to Equity ratio times 2.82 43.52 8.97 1.33 1.19 1.36 9.86
Inc
Debt to Capitalization ratio times 0.76 0.98 0.91 0.60 0.57 0.60 0.74
Total Debt to Total Equity ratio times 6.81 102.14 20.66 3.73 3.66 3.63 23.44

Total Debt to Total Assets ratio % 87.20 99.03 95.38 78.85 78.55 78.39 86.23
Interest coverage times 1.91 (0.38) 0.003 2.68 3.35 3.60 1.86
Earnings to Fixed Charges ratio times 1.61 0.22 0.50 1.40 1.71 1.66 1.18
Operating cash flow to total debt times 0.23 (0.06) 0.06 0.21 0.17 0.01 0.10
Delta Air Lines, Inc Long-term Debt to Equity ratio times 0.79 17.63 63.94 14.69 (8.49) (5.20) 13.89
Debt to Capitalization ratio times 0.46 0.95 0.99 0.94 1.11 1.20 0.94
Total Debt to Total Equity ratio times 2.21 50.58 177.73 47.15 (32.16) (21.91) 37.27
Interest coverage times 1.68 0.16 0.06 2.19 2.03 2.60 1.45
Earnings to Fixed Charges ratio times 2.99 (8.12) 0.08 1.37 1.51 1.71 (0.08)
AMR Corporation Long-term Debt to Equity ratio times 3.80 (3.07) (3.03) (2.35) (0.94) (0.89) (1.08)
(American Airlines) Debt to Capitalization ratio times 0.81 1.37 1.43 1.55 7.41 15.57 4.69
Total Debt to Total Equity ratio times 9.75 (9.58) (8.29) (7.36) (4.35) (3.94) (3.96)
Interest coverage times 1.09 (0.88) (1.19) 0.39 (0.42) 0.81 (0.03)
Earnings to Fixed Charges ratio times 1.31 (0.74) (0.52) 0.59 (0.49) (1.21) (0.18)
Southwest Airlines, Long-term Debt to Equity ratio times 0.30 0.71 0.61 0.46 0.45 0.41 0.49
Co Debt to Capitalization ratio times 0.23 0.43 0.39 0.35 0.35 0.31 0.34
(In U.S dollars) 2007 2008 2009 2010 2011 2012 Ave.
for 6
years
U.S Airways Group, Long-term Debt to Equity ratio times 2.11 (7.33) (11.34) 47.65 27.53 5.54 10.69
Inc Debt to Capitalization ratio times 0.69 1.14 1.09 0.98 0.97 0.86 0.95
Total Debt to Total Equity ratio times 4.59 (15.60) (22.00) 92.08 54.57 10.89 20.76
JetBlue Airways Long-term Debt to Equity ratio times 2.50 2.27 1.89 1.72 1.62 1.30 1.88
Corp. Debt to Capitalization ratio times 0.75 0.71 0.68 0.65 0.64 0.60 0.67
Alaska Air Group, Long-term Debt to Equity ratio times 1.10 2.41 1.95 1.19 0.94 0.61 1.37
Inc Debt to Capitalization ratio times 0.56 0.74 0.68 0.58 0.53 0.42 0.58
Operating cash flow to total debt times 0.37 0.09 0.16 0.36 0.53 0.73 0.37
Average values for Long-term Debt to Equity ratio times 2.06 6.64 7.54 8.99 3.58 3.31
selected debt and Debt to Capitalization ratio times 0.63 0.96 0.96 0.82 1.56 2.57
coverage ratios of eight
leading U.S airlines for Total Debt to Total Equity ratio times 5.18 16.26 21.25 20.69 6.23 9.15
each given year Total Debt to Total Assets ratio % 79.32 94.70 93.63 87.45 89.92 89.67
Interest coverage times 3.05 (0.52) 0.64 2.90 2.72 3.92
Earnings to Fixed Charges ratio times 2.07 (1.59) 0.72 1.71 1.45 1.62
Operating cash flow to total debt times 0.35 (0.13) 0.12 0.23 0.23 0.28

*Note: the followings have to be taken into account when analyzing debt and coverage ratios.
1. Long-term debt also contains long-term capital lease obligations.
2. Debt used in calculating the ratios of Debt to Capitalization and Cash flows to Debt is defined as a sum of short-term borrowing, current
portion of long-term debt and capital lease and long-term debt including capital lease, less current maturities whereas capitalization includes
mentioned debt items plus total stockholders' equity.
3. In the formula of ratios of Total Debt/Total Equity and Total Debt/Total Assets total debt has been considered as total liabilities.
4. In calculating the interest coverage ratio, EBIT is from ongoing operations adjusted to exclude special items.
Acknowledgements
I would like to express my gratitude to Prof. Dr. Petru Stefea and Prof. Dr. Andrei Pelin for the
continuous support and help.
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374


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